In Puerto Rico, a skirmish over how much debt the bankrupt island can handle

On Jan. 31, in Comerio, Puerto Rico, Angel Colon carries containers with water as he walks past a hut, where he has lived since his house was destroyed by Hurricane Maria in September. (Alvin Baez/Reuters)

The $16 billion aid package that Congress approved for Puerto Rico as part of the budget deal this month came as a relief to the territory’s government. It also came as a relief to its bondholders.

The price of Puerto Rican commonwealth bonds have soared since Congress passed the rescue package. Though the bankrupt territory has halted interest payments on its bonds, investors — including hedge funds — drove up the price of the general obligation bond due 2035 by 11 percent on Wednesday. The average price of the bond Frida was 32.01 cents on the dollar, up 26 percent for the week.

The source of investors’ hopes is a new Puerto Rican fiscal plan issued Feb. 12 that sharply raised forecasts for cash flow and long-range sustainable debt that the territory made before Congress acted. By fiscal year 2023, the government would accumulate a $2.8 billion surplus, the plan says.

The stronger forecasts raised fears among some U.S. lawmakers that the new federal funds — earmarked for Medicaid, housing reconstruction and money to repair other damage from Hurricane Maria — would indirectly flow to Puerto Rico’s bondholders.

“We need to be unambiguously clear that the money Congress approved was for rebuilding Puerto Rico and to aid its citizens, not to line the pockets of Wall Street investors that bought the Island’s debt on the cheap,” Rep. Nydia M. Velázquez (D-N.Y.) said in a statement Friday. “It would be a moral outrage if money intended for Puerto Rico’s vulnerable was siphoned off to creditors and vulture funds.”

Velázquez and six other lawmakers wrote to the board created by the Puerto Rico Oversight, Management and Economic Stability Act to make sure the funding from Congress is going to the right places.

At the same time, bondholders were not satisfied with the new fiscal plan. It “is built on sparse data and outright mischaracterizations,” said a group of creditors that includes the bond insurers Ambac and MBIA and other major institutions and individuals in Puerto Rico and on the mainland.

The oversight board must by law review the fiscal plan drawn up by the commonwealth government. Natalie Jaresko, the board’s executive director, would not comment on the prospects for a recovery for bondholders, except to say that “the capacity to pay can only exist with a growing economy.”

Jaresko said that the support from Congress would be “short-lived. It’s a couple of years. If you don’t use that cushion to make structural reforms, you would return to the economic decline trend pre-hurricane.”

She said “the island must use the time and growth over the next couple of years . . . to make the changes required for Puerto Rico to come out of that much stronger, much more competitive.”

Some analysts said the changes in the fiscal plan did not mean that bondholders could expect a better deal. Any surplus could be used for further stimulus either through spending or tax cuts.

“Certainly, federal funds earmarked for recovery and reconstruction should not under any circumstances be utilized for debt service,” said Sergio Marxuach, public policy director for the Center for a New Economy, an independent Puerto Rican think tank. “In theory that surplus could be used to pay some debt service to bondholders,” but, he said, “it would be a big mistake to use that to service the debt. The number one priority should be to grow the economy, and any such surpluses should be directed to public investment.”

In the new fiscal plan, the Puerto Rican government raised forecasts it made less than three weeks earlier. Now it says that it expects to have positive cash flow in as little as two years and topping $1 billion a year starting 2020 — creating a target for bondholders eager to convince the bankruptcy court that the island can soon resume interest payments. Earlier the commonwealth said it would not be able to restart interest payments for at least five years.

The new plan also says that the battered island can sustain anywhere from $3.9 billion to $27 billion in debt, a figure that suggests that owners of Puerto Rican government debt could escape with as little as a 45 percent “haircut” in the value of its bonds.

That is a much higher range than the Puerto Rican government estimated just 20 days earlier. Its Jan. 24 fiscal plan forecast sustainable debt ranging from roughly $2.5 billion to less than $15 billion — which would mean a much tougher deal for bondholders.

Marxuach said that the analysis done by his center concludes that Puerto Rico should not pay any debt during the next five years and that the bankruptcy court should agree to wipe out 70 percent to 80 percent of outstanding debts.

The island’s creditors do not agree.

“Although every strained municipality would love to avoid paying its debts, Puerto Rico’s government cannot expect creditors to accept and trust a document built on fiscal metrics that are analytically flawed and completely inconsistent with historical precedent,” said a statement from the group of creditors that includes Ambac and MBIA. The group said that the fiscal plan was “completely lacking a foundation for revitalizing the local economy and restoring access to the capital markets.”

The fiscal plan only applies to the commonwealth and does not include the bankrupt Puerto Rico Electric Power Authority (PREPA), which on Thursday told a bankruptcy judge in New York that it was running out of money. District Court Judge Laura Taylor Swain rejected PREPA’s plea for a loan from the island’s government.

On Friday, PREPA said it would activate an “operational emergency plan” that would slow recovery from the power losses caused by the hurricane. About 20 percent of Puerto Ricans are still without electricity.

Controversy is also simmering over who has ultimate authority over PREPA. The oversight board, concerned about corruption and bloated payrolls, wants to play a bigger role. So does an independent Puerto Rico Energy Commission created in 2014. But Puerto Rican Gov. Ricardo Rosselló wants to control the utility himself.

Last week Rosselló riled some of his congressional allies in Washington by drawing up plans to change the three-person energy commission into a one-person commission whose sole member could be dismissed by the governor without cause.

Members of Congress see the energy commission as akin to public service bodies on the mainland. Those have wide authority to protect consumers. Moreover, the recent financial aid package Congress passed calls on the Puerto Rico Energy Commission to oversee and audit the spending of federal funds.

Although Rossello has been at odds with the financial oversight board, the two are widely believed to be in agreement on downgrading the role of the energy commission.

A recent policy statement from the commission complained that the utility “in recent months has been resisting the commission’s authority — revealing a wish to return to the days of unregulated, politically influenced monopoly behavior that so ill-served the Commonwealth.”

Steven MufsonSteven Mufson covers energy and other financial matters. Since joining The Washington Post in 1989, he has covered economic policy, China, U.S. diplomacy, energy and the White House. Earlier he worked for The Wall Street Journal in New York, London and Johannesburg. Follow